AU­DIT EX­AM­I­NA­TIONS ON EX­CES­SIVE

The Bond Buyer - - Front Page - BY BRIAN TUMULTY

cost of is­suance for pri­vate ac­tiv­ity bonds, de­fea­sance, and pub­lic safety or jail bonds are part of the In­ter­nal Rev­enue Ser­vice com­pli­ance strat­egy for the 2019 fis­cal year that be­gan Oct. 1

WASH­ING­TON -- Au­dit ex­am­i­na­tions on ex­ces­sive cost of is­suance for pri­vate ac­tiv­ity bonds, de­fea­sance, and pub­lic safety or jail bonds are part of the In­ter­nal Rev­enue Ser­vice com­pli­ance strat­egy for the 2019 fis­cal year that be­gan Oct. 1.

All three ar­eas are new ad­di­tions to the work plan of the Tax Ex­empt and Gov­ern­ment En­ti­ties Busi­ness Op­er­at­ing Divi­sion, IRS of­fi­cials said.

David Hor­ton, the act­ing TE/GE com­mis­sioner, and Robert Choi, the act­ing deputy, in­cluded the com­pli­ance strat­egy in a 2019 pro­gram let­ter posted on the IRS web­site.

Last year the 2018 IRS work plan for the divi­sion in­cluded hedge ter­mi­na­tions; eco­nomic life and weighted av­er­age ma­tu­rity); safe har­bors for guar­an­teed in­vest­ment con­tracts; and rules for qual­i­fied hedges.

The IRS de­clined com­ment on the shift in au­dit pri­or­i­ties for 2019, but Ed Oswald, a tax part­ner at Or­rick Her­ring­ton & Sut­cliffe in Wash­ing­ton, said it’s nor­mal.

“Each year strate­gi­cally they gen­er­ally fo­cus on dif­fer­ent sub­jects,” Oswald said. “Per­haps if there is a prob­lem they con­tinue.”

Ex­ces­sive cost of is­suance that would ad­versely im­pact the tax-ex­empt sta­tus of pri­vate ac­tiv­ity bonds was the topic the IRS most re­cently cov­ered in an “is­sue snap­shot” that was pub­lished on its web­site.

The July 27 is­sue snap­shot pro­vided 10 ex­am­ples of costs that are sub­ject to the 2% lim­i­ta­tion on is­suance costs as well as sev­eral au­dit tips.

“I think that’s an in­ter­est­ing tie-in,” said Vicky Tsi­las, a part­ner at Bal­lard Spahr who re­cently headed Branch 5 in the IRS Chief Coun­sel’s Of­fice. “The IRS has been pub­lish­ing snap­shots, which are ba­si­cally two pages, and folks have been ask­ing, ‘Do these ac­tu­ally sig­nify what the IRS is go­ing to be tar­get­ing?’ and the IRS says, ‘Well, not nec­es­sar­ily.’”

Oswald said the 2% cost of is­suance lim­i­ta­tion for PABs could be “a fruit­ful area” for IRS en­force­ment. “Given that the 2% limit is a bright line, for a reg­u­la­tor to look at it, is cer­tainly rea­son­able,” he said.

Vi­o­la­tions of the 2% lim­i­ta­tion may be most likely for smaller is­suances. Oswald said the 2% lim­i­ta­tion might be met at the clos­ing, but a few weeks later the is­suer may get an­other bill and pay it, re­sult­ing an un­in­tended er­ror.

No­tices of de­fea­sance are re­quired to be filed with the IRS. For in­stance, a univer­sity might have is­sued tax-ex­empt bonds to pay for con­struc­tion of mul­ti­ple build­ings, but years later de­cide to sell one of them and de­fease the bonds by tak­ing them off the market.

Oswald spec­u­lated that the IRS will re­view those fil­ings to de­ter­mine whether the con­di­tions were met and dou­ble check the math.

As for pub­lic safety bonds, Tsi­las said she in­ter­prets that com­pli­ance area as fo­cus­ing on “the jail fa­cil­i­ties and they have been au­dit­ing those for a cou­ple of year now.”

The Bond Buyer has re­ported on sev­eral au­dits where tax-ex­empt bonds is­sued for jails and de­ten­tion fa­cil­i­ties have been de­ter­mined to be tax­able be­cause of an ex­cess pri­vate use of the fa­cil­ity. Of­ten it has in­volved con­tracts is­suers or bor­row­ers have with the U.S. Mar­shals Ser­vice or U.S. Im­mi­gra­tion and Cus­toms En­force­ment to house fed­eral pris­on­ers be­ing de­tained as un­doc­u­mented im­mi­grants.

“Over the last three years, I would say the IRS has been tar­get­ing these jail fa­cil­i­ties and The Bond Buyer has re­ported on them,” Tsi­las said. “To me it sig­ni­fies they don’t in­tend to let up on these au­dits.”

Oswald agreed “this is maybe a lit­tle more of the same be­cause they found some prob­lems there and are look­ing more.”

“For peo­ple not steeped in this, ev­ery­one kind of knows what pri­vate busi­ness use is,” Oswald said. “When you em­pha­size that the fed­eral gov­ern­ment is treated as pri­vate busi­ness use, peo­ple are of­ten dumb­founded by that, ask­ing, ‘How can that be?’”

The choices made by the IRS for its au­dit pri­or­i­ties have be­come “even more of a black box” since the ser­vice be­gan us­ing a data drive ap­proach, said Todd Cooper, a part­ner at Locke Lord who chairs the Amer­i­can Bar As­so­ci­a­tion’s tax­a­tion sec­tion’s tax-ex­empt fi­nanc­ing com­mit­tee. ◽

Vicky Tsi­las, Bal­lard Spahr part­ner, said the IRS won’t let up on jail au­dits.

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